Interchange Rule Draws Flak

The Federal Reserve's most recent update of its rule implementing the Durbin amendment makes it a bit better for most CUs but leaves most of their deep concerns about the measure untouched.

That is the consensus of card processing and CUSO executives charged with helping credit unions craft a debit strategy in the face of what may be a slowly declining source of income.

The most obvious good news, for credit unions, analysts said, is that the Fed backed away from the initial possibility of requiring card issuers to participate in as many as four separate signature debit and PIN debit networks and instead agreed that card issuers could just belong to two unaffiliated debit networks.

Credit unions benefit from this change in particular, according to Tony Emrick, a senior vice president with the Vantiv card processor, because it eliminates a potentially large requirement that both change the way they do business as well as issue entirely new plastic.

Previously known as Fifth Third Processing Solutions, Vantiv processes card transactions for over 2000 financial institutions, including credit unions but also processes transactions for merchants.

“Right now, according to the new law, it would be completely legal for a credit union to have one signature debit payment network and one PIN-based payment network,” Emrick told to a NAFCU-sponsored webinar that looked at the final debit rule, adding later that this might be a good strategy to help a CU better protect its debit interchange.

Emrick and other executives agreed that, at least for the short term, most credit unions and other issuers will not be affected by the change in the overall debit interchange cap. Nearly all credit unions are exempt because they have less than $10 billion in assets. And Emrick also said that he and other card processing executives were now fairly confident that card processors would develop a dual interchange schedule to support the exemption.

For those large issuers, the Fed increased the regulated interchange rate from the initial effective cap of 12 cents per transaction to one that is at least 21 cents per transaction plus 5 basis points of the transaction as an ad valorem amount meant to cover the costs of fraud. The rule included an additional penny if the card issuer can show it has taken reasonable steps to prevent fraud.

In practical terms, for an issuer of over $10 billion in assets, the interchange on a $50 transaction went from being possibly as low as 12 cents under the initial rule to a bit more than 22 cents under the modified rule, assuming the issuer takes the steps to qualify for the additional one cent fraud prevention premium.

In addition, the Fed pushed the effective date of the rule to Oct. 1, 2011 thus giving the industry a bit more time to make all the needed changes.

But the updated rule did not add any changes that would protect debit interchange for credit unions and other issuers of less than $10 billion from an eventual decline that Emrick and other analysts believed is very likely.

The decline will come because the regulation essentially shifts the interests of processors from card issuers to merchants, they said.

Merchants under the regulation will be able to choose to route their debit transactions among a variety of processors and analysts believe it is likely that, without a changed regulation, a discounted interchange rate to small issuers will become one of the things processors use to attract new business from merchants.

“There may be a variety of grounds that processors will use to compete,” Emrick said, including discounted debit interchange but also covering reduced fee structures, improved process reporting and other measures. While he said he believes all processors, initially, will support a dual interchange schedule, he didn't know of any that are committed to supporting one into the future.

But there are also indications that the Federal Reserve is aware of the potential decline and that it will revisit the regulation and another analyst believed this is almost a certainty.

Andy Brown, director of product marketing for ACI Worldwide, a payments software developer and a long time international debit industry analyst, said such regulatory tinkering has precedent around the world.

Based on the experiences in other countries which have also capped debit interchange, credit unions should expect to see the Federal Reserve revisit its Durbin amendment regulations in the next one to two years.

Addressing a telephone conference call addressing the impact of the regulations, Brown pointed out that in every other country that has capped debit interchange, regulators had to make changes or fixes to the existing rule.

Brown also observed that Federal Reserve Chairman Ben Bernanke hinted at the possibility when he noted the regulator would be paying attention to how the small issuer exemption to the cap worked or failed to work.

But other executives urged CUs not to focus as much on the downsides of the Durbin rule but to also look at the opportunities it presented.

For example, PSCU Financial Services, a leading card processing CUSO, has urged credit unions to refrain from adding fees to checking accounts or debit cards in reaction to the cap.

PSCU CEO Michael Kelly stressed that the regulated interchange cap still has the potential to give most CUs a competitive advantage in the market for checking accounts and debit cards.

“The Federal Reserve Board acknowledged what we have been saying all along–that merchants are not required to pass along the effect of lower interchange fees in the form of lower prices to consumers,” Kelly said in a statement. “The prospect of reduced interchange rates for large banks has already prompted them to increase fees. While this can negatively impact consumers, it is a bonus for credit unions because it makes their debit cards even more attractive. Now is definitely not the time for credit unions to raise fees on checking or debit offerings. Credit unions need to seize this opportunity to win market share from banks by attracting members with these loyalty-driven products,” he added.